Excellence Optoelectronics' (TWSE:6288) Earnings Are Weaker Than They Seem

Investors were disappointed with Excellence Optoelectronics Inc.'s (TWSE:6288) earnings, despite the strong profit numbers. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

Check out our latest analysis for Excellence Optoelectronics

A Closer Look At Excellence Optoelectronics' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Excellence Optoelectronics has an accrual ratio of 0.20 for the year to September 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of NT$70.2m, a look at free cash flow indicates it actually burnt through NT$900m in the last year. We also note that Excellence Optoelectronics' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of NT$900m. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Excellence Optoelectronics increased the number of shares on issue by 6.2% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Excellence Optoelectronics' EPS by clicking here.

A Look At The Impact Of Excellence Optoelectronics' Dilution On Its Earnings Per Share (EPS)

We don't have any data on the company's profits from three years ago. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. What we do know is that while it's great to see a profit over the last twelve months, that profit would have been better, on a per share basis, if the company hadn't needed to issue shares. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, if Excellence Optoelectronics' earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Excellence Optoelectronics' Profit Performance

As it turns out, Excellence Optoelectronics couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). Considering all this we'd argue Excellence Optoelectronics' profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, Excellence Optoelectronics has 5 warning signs (and 3 which are concerning) we think you should know about.

Our examination of Excellence Optoelectronics has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.